So I wound up buying Bernstein's "Primer on Money, Banking and Gold" which is useful if outdated. I feel like I finally do more-or-less "get" how banks create credit money and how the Federal Reserve exercises control over their creation of credit money.

I still find murky certain things about monetary policy, for example, if money supply is supposed to bear some relation to total productive output in the economy, why is it a good idea to increase the money supply when the economy is in recession, and how is it that that doesn't always lead to some kind of inflation, e.g. right now, where we are supposedly seeing a huge increase in the money supply and low inflation?

i'm totally thinking of this in simcity terms, but if you have population growth + technological growth, but your money supply remains the same, then you end up in a deflationary spiral. like say you have a city of 10 people with stone age tech and total money supply of $100. one year later, you have 20 people with ipod tech, but still $100, so the two guys with the $100 have no incentive to spend it, because if they wait another year, they can own 40 people and get a super ipod for the same amount of $. as sim city zeus, you should just print up extra $ and distribute it the the rest of the 98 people so your economy doesn't collapse.

maybe that's bad example -- think of it this way maybe: you and vincent van gogh are the only human beings alive and you have $100 and vincent has nothing but a painting. So the painting is worth max of $100 because that's all the money there is. Say vincent paints another painting. now the value of your dollar has shot up, because you could potentially buy two paintings instead of just one before. the aliens who control the monetary supply should really put more money into your two-person economy.

Here's my shot at how the argument goes -- I'm not endorsing it necessarily. Typically in a recession, arguably, there are opportunities that are not acted on because the carrying cost of capital is too high. I.e. if you put in x dollars into these places, you will get back more than x dollars, but less than the rate at which you can borrow those x dollars. The reason the cost of capital is too high is because everyone is afraid of lending out capital because, hey, recession, lots of things have been losing money, so better to sit on it. This is a liquidity crunch. Therefore if we lower the cost of capital then those opportunities will get acted upon and begin to cause liquidity to flow through the economy and the liquidity crunch goes away.

However, these days, things are different because we are in a liquidity trap. The cost of capital is already cheap. But there are few profitable opportunities (risk adjusted) even at this low cost of capital. We have not too little liquidity, but too much. However, that liquidity isn't rapidly circulating and "overheating" the economy. It's just sort of sitting there in private bank accounts and the like. So we don't really get inflation, since the money isn't used to bit up the prices of assets (though we have seen a few asset bubbles come and go, actually!).

Yeah that's a pretty good explanation. So then wouldn't that suggest that injecting further liquidity into the system on the capital/banking side is not going to do any good? I mean I guess that's why a lot of left-leaning economist talk about the need for more stimulus that's more on the demand side.

what i don't understand is why the govt simply doesn't print/create more money and immediately use it to pay off debt/send stimulus checks out. apparently this already does happen on a small scale when the US mint comes out with new quarters or whatever and collectors buy them instead of putting them out in circulation. i guess that's more like a hidden tax on hoarders rather than actually increasing the money supply but still.

wouldn't that suggest that injecting further liquidity into the system on the capital/banking side is not going to do any good? I mean I guess that's why a lot of left-leaning economist talk about the need for more stimulus that's more on the demand side.

Exactly. but the argument goes (at least by some -- like everything about monetary policy, different schools will disagree about basically everything) that even in a liquidity trap, where the effective interest rate "should be" below zero, while the government can't drive the rate lower, it can simply increase the amount of money sloshing about to the point where people feel obliged to direct some of it towards something or other. That's basically one way to look at quantitative easing.

The other way to look at quantitative easing is that you have a huge contraction in what people thought constituted wealth (in the form of lots of paper turning out to be worthless) so you increase the money supply directly to offset what would otherwise be a very deflationary force. You can also think of this as offsetting the diminished "velocity" of money. There are other ways to look at it too (much more negative).

And of course the U.S. could "print more money" (that's not precisely what easing is, but...) and give out more stimulus, and the reasons why it doesn't are more political than anything else. Part of which is exactly transmitted as that fear of the "inflation genie" (which of course plenty of other economists can argue very convincingly is not in any bottles at this moment because there is in fact a liquidity trap, look at Japan and what happened there, etc., etc.)

So I've had this idea of things in my head for a while, and maybe you understand the situation well enough to tell me whether it makes sense. You say

The other way to look at quantitative easing is that you have a huge contraction in what people thought constituted wealth (in the form of lots of paper turning out to be worthless) so you increase the money supply directly to offset what would otherwise be a very deflationary force. You can also think of this as offsetting the diminished "velocity" of money.

The way I've been thinking about the current economic situation is that the most recent bubble created quite a lot of fake, non-existent value that was really never there in the first place. When all that "wealth" turned out to be worthless, as you say, there is, as you say, "deflationary force." However I would think that you would WANT to deflate non-existent value. So I guess an argument for expanding the money supply is actually to create a kind of "soft-landing" effect, because if you just let all the air come out at a natural rate it would create economic chaos. In other words, in a sense we ARE inflating the economy, but only enough to counter and slow down the effects of deflationary pressure enough to prevent complete panic and a downward spiral.

For example, if mortgage rates are low as a result of monetary policy, I'm more likely to take an "inflated" house off someone else's hands, because my monthly cost is now reduced so I can own the same dollar value amount of house for less money. So maybe instead of that person's home dropping like a rock in value, the value levels off and the economic impact is sort of more spread out. I buy it with a low-rate mortgage, and maybe I don't experience much appreciation in value for a while, but the seller and the holder of the old mortgage get out of a bad situation. Growth is slowed but crisis is averted. Is this a good way of understanding the larger economic situation as well?

The Fed thought quantitative easing would drive interest rates down to negative real rates, forcing investment in riskier, job-producing investments like business loans and capital investment. In reality the major bank recipients used QE funds to turtle up, buy 10-yr Treasuries for the tiny (and negative in real terms) spread, and rebuild their balance sheets. The QE funds that found their way to proprietary trading desks were used for socially non-productive speculation in commodities, and rather little actually splashed out of the finance sector into the real world.

Financial-fraud prosecutions by the Department of Justice are at 20-year lows... (they) are just one third of what they were during the Clinton administration....

Some suggest there is... potential for conflicting interest when the department’s top officials come from lucrative law practices representing the very financial institutions that Justice is supposed to be investigating. “And that’s where they’re going back to,” says Black. “Everybody knows there is a problem with that.” (Two members of Holder’s team have already returned to Covington.)

Meanwhile, Obama’s political operation continued to ask Wall Street for campaign money. A curious pattern developed. A Newsweek examination of campaign finance records shows that, in the weeks before and after last year’s scathing Senate report, several Goldman executives and their families made large donations to Obama’s Victory Fund and related entities, some of them maxing out at the highest individual donation allowed, $35,800, even though 2011 was an electoral off-year. Some of these executives were giving to Obama for the first time.

i'm confused as to why increasing the monetary supply by giving it to the banks is less politically risky than simply using it to directly pay for things, especially since the banks did not do a great job of lending that money out.

QE didn't have "bank recipients" in any real sense. QE is just the fed buying treasuries. The only difference between QE buying of treasuries and non-QE buying of treasuries is that non-QE usually involves short-turm repurchase agreements rather than outright sales, so is targeted at the short-term cost of capital, while QE involves outright purchase of at times longer dated treasuries, and the money used to buy these treasuries strictly-speaking didn't exist before it was electronically credited to the account of the dealer whom the fed purchased the treasuries from.

But it's not as though it involves the fed giving money to specific banks in any real way. It just basically changes the ratio of treasuries/cash in the market.

hurting isn't saying that GS et al are "universal[ly] innocen[t]," he's saying that as far as he knows there may not be any legal grounds to prosecute them. i dunno if i agree -- and i'd like to see the SEC, the IRS and anyone else issue a subpoena or two before making a determination on that issue -- but he isn't saying that they're clean or innocent.

personally, i'd like to believe the "they prosecuted Al Capone for tax fraud" canard -- that is, if the Feds really wanted to nail Goldman Sachs et al they'd find something, ANYTHING and push it as far as they can -- and however much i may suspect that their inaction is b/c they really don't want to go after them, is there any real proof that that IS what is actually happening?!?

I don't really know what the Justice Department is doing apart from making up legal arguments to support the assassination/police state that no one gets to actually read. and prosecuting medical marijuana distributors, I guess.

The idea that you're going to be able to prosecute goldman sachs executives for criminal financial fraud remains one of the most annoying and time-wasting red herrings of the left

― Scott, bass player for Tenth Avenue North (Hurting 2), Thursday

Difficult but not annoying or time wasting (I'd rather have Justice working on such a criminal case even if they lose-- it's not like they're gonna be drafting other legislation to tighten up regulations on wall street or doing other more important things if they're busy on such a case). As Newsweek that well-known left-wing mag noted:

A year later, in April 2011, the Senate Permanent Subcommittee on Investigations, chaired by Democrat Carl Levin, after a two-year inquiry, issued a fat report detailing several transactions, including Goldman's Abacus deal, that Levin and his staff believed should be investigated by Justice as possible crimes. The subcommittee made a formal referral to the department (as did the federal Financial Crisis Inquiry Commission, chaired by Phil Angelides), and Levin publicly stated his view that criminal inquiry was warranted. Goldman executives, including the firm's chief executive officer, Lloyd Blankfein, started hiring defense lawyers.

The Fed is doing both. Something like 60% of Treasury issuance to pay for the continuing insane deficits (35% of Federal spending is borrowed) wound up on the Fed's balance sheet last year. It does pass through banks: the Federal Reserve is a semi-private corporation owned by member banks and chartered by a 1913 act of Congress to get around antitrust concerns.

Also, political objections (in the form of objections to Fed board nominations) have all come from the Tea Party Right of late, which is very opposed to quantitative easing as a debasement of the dollar. Kinda naive, when it did so many good things, like force China further off its peg. In the long term, QE, by debasing the dollar just transfers wealth from savers and the wealthy (ie, the 1±%) to debtors. For the 99%, its terrible if you are a pensioner but ultimately helpful if you're underwater on your mortgage.

Right, inflation is bad for savers of money and people on fixed income, good for people with debt, and kind of neutral for everyone else as long as it doesn't get out of control (all other things being equal, wages rise with inflation).

At the moment, the vast majority of prosecutable fraud from the mortgage bubble arises from "upstream" of the financial engineers at the Wall St. banks. Loan originators who falsified income documentation, appraisers who inflated appraisals to retain business, etc. A strong case can be made that only a few of the mortgage-back security aggregators really knew or care how bad the credit risks had become in the 2005-7 timeframe, so long as some fool in a Dusseldorf landesbank was willing to buy them.

William K. Black, one of the best sources on the lack of prosecution for credit-bubble fraud, IIRC notes that the majority of the white-collar crime investigators at the FBI and other Federal law enforcement agencies were reassigned to investigate money-laundering for terrorist organizations in the aftermath of 9/11. A budgetary request for more hires to replace them was nixed by Congress.

The subcommittee made a formal referral to the department (as did the federal Financial Crisis Inquiry Commission, chaired by Phil Angelides), and Levin publicly stated his view that criminal inquiry was warranted.

Anyway my gripe about that line ("why haven't these guys gone to jail?") is that actionable criminal fraud makes up a tiny portion of what went wrong with our economy, and while it is often metaphorically accurate to say "these guys are crooks", it's rarely literally provably true. Further, it seems to me that the lust for a public hanging kind of distracts from the much bigger, harder systemic problems that need addressing.

if nobody's left to run it because they're all in jail, that seems like an excellent rationale for govt seizing control. i'm not sure, but can the govt be plaintiff against banks in a civil suit? that seems like another avenue to seize assets.

Right, inflation is bad for savers of money and people on fixed income, good for people with debt, and kind of neutral for everyone else as long as it doesn't get out of control (all other things being equal, wages rise with inflation).

this is true but again, we don't really have inflation. we just have low rates, which are also good for debtors and bad for savers (but are also good for equities since it forces money [that wants returns] out of bonds and into riskier investments.). but we don't have prices increasing at a striking rate (recent episodic commodities bubble aside). and i've said this before, but i'm pretty dubious that the low rates are a result of fed policy at all, actually. There's enough demand for relatively safe assets that rates would probably be very low anyway.

Right, didn't mean to suggest we are seeing inflation, although I do think that the expanded money supply has contributed to mini-asset-bubbles. I think what it HAS maybe done is exerted enough upward pressure on prices to keep them from deflating, which is what I meant in my prior post.

That's an interesting theory about the demand for safe assets, and one I hadn't heard. But it seems like it almost has to be true that rates are lower than they would be without fed intervention. I mean the fed has spent, what, over a trillion dollars buying treasuries? And how big is the entire treasury market? 10 trillion? I can't find a clear number in my quick google search, but the additional demand added by the fed's buying would have to make a significant difference to rates, even if they'd be low anyway, I'd think.